Early Look: Japan’s Battle of Diu

"He who ate the chick must also eat the rooster, or pay for it."

-Francisco de Almeida, first viceroy of the Portuguese State of India, circa 1508


Dom Francisco de Almeida (1) was a distinguished Portuguese solider and explorer. Also of noble background as a counselor to King John II of Portugal, he is widely credited with establishing Portuguese hegemony in the India Ocean – paving the way for nearly a century of Portuguese dominance in the Indian Ocean trade.


Before Almeida’s arrival as commander of Portugal’s fourth seaborne voyage to India, the Portuguese Empire had been struggling mightily to establish a stronghold in this globally omnipotent trading hub, failing to cultivate key trading relationships in addition to being denied a meaningful presence at key ports.


The first voyage was commanded by Vasco da Gama (1), who is credited with captaining the first ships to ever sail directly from Europe to India (1498), rounding the Cape of Good Hope into what was previously believed to be a landlocked Indian Ocean.


Beyond his discovery – which is arguably the most important geographic discovery in the history of globalization – his first voyage was a broad failure, losing roughly half his men and two of his four ships.


The second voyage of eight ships was commanded by Alvarez Cabral, which set sail for India’s port cities in 1500. After an inadvertent detour to the coast of Brazil, Cabral and his depleted crew finally docked in Calicut six months later.


Cabral’s brief stay in the region was highlighted by two violent skirmishes with established parties within the region, which perpetuated more largely unsuccessful trading exploits. He hastily retreated to Lisbon with just five men and one ship.


The third voyage was once again commanded by Vasco da Gama. Setting sail in 1502 with a 15-vessel fleet, da Gama’s primary objective was to uproot the Egyptian power preventing Portugal’s establishment of trading dominance in the region.


To some degree, da Gama found a fair amount of “success” – particularly in combat. His fleet is credited with burning alive 250 men, women and children on a ship, as well as slaughtering 800 fishermen in Calicut. Shortly after his ruthless exploits, he traveled to neighboring Cochin where he defied local wishes and set up a well-forfeited trading factory.


A costly tactical error would have cost the Portuguese all of their progress in India when Cochin was overran by Calicut forces, had it not been for the timely arrival of our “hero” Francisco de Almeida.


Under several years of the viceroy’s leadership, Portugal was able to make solid headway into Indian Ocean trade. His eventual victory over a joint fleet of Gujarat, Egyptian, Calicut, Ottoman, Venetian, and Ragusa forces in the Battle of Diu (1509) cemented Portugal’s dominance within the region and ultimately allowed the empire’s trading and transport strategies to flourish.


It is believed that had Almeida’s son Lourenco de Almeida not been murdered by a joint Gujarat-Egyptian fleet in the First Battle of Chaul, the decisive Portuguese victory mere months later at the Battle of Diu would have eluded the history books. The battle itself was pursued as a personal outlet for Almeida to avenge the death of his son, which is the origin of the highlighted quote above.


Motivated by the pain of a lost child, Almeida’s hasty foray into battle helped the Portuguese Empire finally overcome the headwinds to Portuguese dominance of the world’s most important trading route at the time.


If this colorful story of persistent failures preceding ultimate triumph reminds us of anything, it’s modern-day Japan. Plagued by persistent deflation (10YR average annual CPI = -0.2%) and nonexistent growth (10YR average annual nominal GDP growth = -0.7%), the Japanese economy has long been failing to establish itself as anything remotely resembling vibrant, dynamic or just plain healthy.


If Japan is the modern-day version of the Portuguese Empire – oft seeking, but not finding – then Japanese policymakers have undoubtedly been reincarnated versions of Vasco da Gama and Alvarez Cabral, multiplied many times over.


For over ten years now, Japanese policymakers have implemented a variety of “counter-structural” strategies (i.e. there’s absolutely nothing cyclical about Japan’s economic malaise) designed to overcome deflation and perpetuate nominal GDP growth: perpetual ZIRP, quantitative easing, comprehensive monetary easing, bloated sovereign deficits, etc.


All have failed to deliver the Japanese economy the inflation and nominal growth it has so desperately sought.


Enter recently-elected prime minster Shinzo Abe, who we think has a chance to be Japan’s modern-day version of Francisco de Almeida. Abe, head of the ruling Liberal Democratic Party (LDP), can indeed be said to be motivated by the “blood of a son”.


The LDP has long been the dominant political party in Japan. With the exception of a brief 11-month period between 1993 and 1994, the LDP was in power from 1995 through 2009, when it was flat-out dominated by rival Democratic Party of Japan (DPJ) in the AUG ’09 general election (308 to 119 seats).


On the strength of party leader Shinzo Abe’s pledge to proactively pursue a nominal growth target of +3% and an inflation target of +2%, the LDP was able to take back control of the Lower House to the tune of 294 seats vs. only  57 for the DPJ in the DEC ’12 general election.


Focused intently on the previous failures of Japanese policymakers (particularly the central bank) to deliver the goods, Abe has adopted a very open and aggressive anti-deflation stance in the media. His appointment of Taro Aso as Finance Minster is yet another signal that he is prepared to do what it takes to win Japan’s version of the Battle of Diu.


As outlined in our 12/26 note titled: “JAPAN TO LOOSEN FISCAL POLICY AS WELL”, the following is a list of the strategies we think Abe will purse to emulate Almeida’s success in the 1509 version of the battle – which the latter won by leading off with a massive naval bombardment that was followed up by the larger Portuguese ships pelting enemy vessels from afar with technically-advanced weaponry that was far superior to that of their opponents:

  • A +2-3% joint Diet-BOJ INFLATION target (likely at the JAN 21-22 BOJ board meeting);
  • A meaningful expansion of public expenditures and “large scale” stimulus package (additional details in the coming weeks);
  • A VAT hike delay (discussions to begin in late 2013);
  • The LDP wins a majority in the Upper House pending elections late-JUL/early-AUG, paving the way for a full-fledged assault on Japan’s public finances;
  • An erosion of BOJ independence, with the BOJ governorship and two deputy governorships eventually assumed by politicized puppets (late-MAR/early-APR); and
  • Experimental monetary POLICY – particularly a foreign asset purchase program (likely several weeks after the previous catalyst materializes).

All told, we are of the view that a true phase change in the Japanese economy is definitely underway. While some may still be viewing Abe through the same lens as previous Japanese policymakers, we think it will continue to pay to be short the Japanese yen with respect to the intermediate-term TREND and long-term TAIL.


And while we continue to view incremental monetary Policies To Inflate and expansionary fiscal POLICY as reflationary for Japanese equities and supportive of regional sentiment in the near term, we continue to flag material risk of Japanese currency and sovereign debt crises borne out of those same policies with respect to the long-term TAIL.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, VIX, and the SP500 are now $1, $110.28-112.82, $80.26-80.81, $1.29-1.31, 1.84-1.96%, 13.34-16.03, and 1, respectively.


Darius Dale

Senior Analyst


Early Look: Japan’s Battle of Diu - Chart of the Day


Early Look: Japan’s Battle of Diu - Virtual Portfolio



The Macau Metro Monitor, January 10, 2013




Secretary Tam said that although new resorts have been approved by the government in recent months, it would take some time before they are constructed, and he expects the growth of new gaming tables to be very limited up to 2015.  The government has set an annual growth ceiling at 3% for the coming 10 years.  Tam said the new tables being granted by the government will mainly be allocated to the newly opened larger casino-resorts that are complying with the authority’s strategy for diversification towards more non-gaming business such as Sands Cotai Central and Galaxy.  In reference to the 3% growth of new tables for this year, Tam said the authority would grant them to the five casino-resorts on Cotai in proportion to their non-gaming business. 


Yesterday, Sands China's COO David Sisk said he expects to get 200 new gaming tables allotted to Sands Cotai Central casino resort within the first quarter of 2013.



Sands COO David Sisk said, “We follow what the government asked us to do, in terms of allocating between 50% of our smoking space and 50% of our non-smoking casino space, so we followed what the government told us to do.  The government came in and evaluated and approved; both the DICJ and the health department were involved in the measures.  We felt we’ve done the appropriate thing. We’re comfortable with how we’ve allocated our tables and slots, and we believe we did it in the best business interests of our company, as well as the interests of our employees… I can’t speak for what the other [casinos] did, but I think they probably did appropriately as well,” Sisk said.  “We took the appropriate actions for our employees and for our business. Whether that meant that there may be more tables in one area or another, I don’t think that is the real issue for us,” he continued. 



MGM CEO Jim Murren says that the profits of MGM China are set to more than double once the gaming operator opens a casino resort in Cotai.  He also said that he forecasts Macau’s casino gross gaming revenue to rise by mid-to-high double digits in 2013.

MGM China CEO Grant Bowie said the company hopes to make an announcement on the construction timetable “within the next six to eight weeks”.  Bowie said the company was currently liaising with the Lands, Public Works and Transport Bureau to organize the necessary permissions to start construction.  “Once we get our building approvals, the next phase will be to make a full announcement on the whole development and the branding of the project,” he said.


Angela Leong On Kei, executive director of SJM said the company would raise its employees’ wages as soon as it is approved by SJM's shareholders.  Last year, SJM increased its staff wages between 5-10% – the percentage of the increase was based on salaries, with employees with lower salaries getting higher raises.



Taiwanese prosecutors said they were investigating a locally-based Hong Kong firm for allegedly carrying out huge money transfers for use in Macau casinos, circumventing strict forex rules.  The company, which opened in Taiwan in 2009, allegedly accepted deposits by Taiwanese gamblers allowing them to withdraw the money once they were in Macau, said the Taipei district prosecutors’ office.  Prosecutors, who declined to identify the firm, said they suspected it was behind a total of US$179 million in illegal transactions.


The head of the company was questioned on Wednesday on suspicion of violating Taiwanese law, which stipulates only banks are allowed to handle domestic and international money transfers, it said in a statement.

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Starbucks has two, potentially major, tailwinds in FY13 that could push the stock higher.  Sentiment is a cause for concern but at this price we are positive on the stock.



Key Levels


From a trading perspective, our macro team’s quant model is indicating that SBUX is in a bullish formation, with immediate-term TRADE and intermediate-term TREND support at $53.39 and $51.37, respectively.


SBUX TAILWINDS IN FY13 - sbux levels



Fundamental View


We believe that Starbucks is set to post another strong year in FY13 with its revenue drivers firing on all cylinders, coffee prices down ~40% year-over-year, and a macro outlook that suggests that the company’s high degree of leverage to the US economy could prove to be a benefit. 


Revenues are expected to grow 12.7% in FY13, versus FY12, by the Street.  We believe that this is possibly conservative given continuing momentum in CPG, including single serve, and the core retail business. 


We believe that the flow of positive news regarding Starbucks, to which we have become accustomed, will continue in 2013:

  • CPG could surprise to the upside as the availability of Evolution Fresh is expanded and the company continues to take share in single serve. 
  • International growth, particularly in China, was a key focus of the investor conference at the beginning of December and we expect management to continue to underline this potential throughout FY13
  • Coffee costs constitute a significant tailwind and we expect incremental positive commentary on input costs to continue in FY13.  Coffee needs are locked through 1HFY14 but, given the price decline since the company's most recent guidance, more positive news seems likely


Leverage in the P&L


Starbucks is part of a small group within the restaurant space that it is likely to see significant leverage in its P&L over the next 12 months. We believe, especially in casual dining, that consensus is overly optimistic about companies’ ability to grow earnings significantly faster than sales over the next year.


With strong momentum, effective sales initiatives, a fully-loaded CPG division, and impressive unit growth both domestically and internationally, we believe that top- and bottom-line estimates for Starbucks are likely to rise over the next three months.


SBUX TAILWINDS IN FY13 - sbux eps vs sales growth





Howard Penney

Managing Director


Rory Green

Senior Analyst


Getting Religion

This note was originally published at 8am on December 27, 2012 for Hedgeye subscribers.

“Affairs are easier of entrance than exit; and it is but common prudence to see our way out before we venture in.”



Yesterday morning I was in the Canadian ski town of Banff, Alberta and today I found myself in Park City, Utah.  Since this is my first trip to Park City, I must admit it is a very picturesque town.  In fact, the beauty here almost offsets the fact the beers and cocktails are all watered down.  Almost being the key word.  But enough beating around the bush, today I’m going to jump right into it.


Yesterday morning in the Early Look I noted that violating the debt ceiling was imminent.  Coincidentally or not, later in the day yesterday Treasury Secretary Geithner issued a press release stating that the statutory debt limit would be violated by December 31st but that the Treasury department could take extraordinary measures to extend the ceiling by an additional $200 billion.  In the press release, it was also noted that:


1.)    The extraordinary measures can create approximately $200B in headroom under the debt limit; and


2.)    Under normal circumstances, that amount of headroom would last approximately two months. However, given the significant uncertainty that now exists with regard to unresolved tax and spending policies for 2013, it is not possible to predict the effective duration of these measures.


To summarize: while there may be two more months of flexibility, the uncertain policy environment makes it difficult to project.  So, just as he is preparing to exit stage door left, Geithner sticks the markets with more uncertainty.  


Managing through the fiscal and monetary crises that is looming over the next couple of months would actually require some discipline and willpower.  Unfortunately, both of those attributes are currently in short supply in the hallowed halls of Congress.  Yesterday, I referenced the book “Willpower” by Roy Baumeister and John Tierney.  The authors actually provide some advice as to how to build willpower.  They write:


“Religious people are less likely than others to develop unhealthy habits, like getting drunk, engaging in risky sex, taking illicit drugs, and smoking cigarettes.  They’re more likely to wear seat belts, visit a dentist, and take vitamins … And they have better self-control, as McCullough and his colleague at the University of Miami, Brian Willoughby, recently concluded after analyzing hundreds of studies of religion and self control over eight decades.”


There you have it, a key way to build will power it to become religious.  Sadly absent a mass baptism, I think it is unlikely that Congress gets fiscal religion in the coming weeks.


Speaking of getting monetary religion, or lack thereof, probably the most noteworthy move in global macro markets over the last month has been the utter collapse of the Japanese Yen.  Shorting the Yen was actually our top Macro idea in our Best Ideas Call back on November 15th. The flip side of this trade has been an inflation of Japanese equities.  The Nikkei 225 is now up 9% for the month of December and 22% for 2012. On one hand, an inflating stock market benefits those that own Japanese equities, but the longer term issue is that this flagrant printing of money actually leads to a loss of confidence in the Japanese currency with the second derivative being a loss of confidence in Japanese government debt.


The more looming concern in Japan may actually be the yet to be implemented fiscal policy of the new administration.  As Darius Dale wrote yesterday in a macro note intraday:


“Abe and Aso will craft a “large-scale” supplementary budget for the FY12 year (likely > ¥10 trillion), as well as a FY13 federal budget. Regarding the latter, the previously-imposed ¥71 trillion spending cap for FY13 was recently disregarded by the LDP, suggesting Abe is poised to take public expenditures to new heights. In short, we think Japan’s pending fiscal and monetary POLICY mix risks igniting a backup in JGB yields that could threaten Japan’s fiscal sustainability, potentially triggering a European-style sovereign debt crisis.”


Now, clearly shorting Japanese government bonds has been called the “Widow Maker” trade for a reason.  The reason being it has been an utter failure of a trade, but Japanese yields and CDS are starting to back up as the Japanese appear to be on the verge of entering a new era of indulgent Keynesian policy. 


The truly scary fact about Japan is that almost 50% of the public budget is financed by debt issuance.  Further, almost a quarter of the annual budget is actually used for debt service.  Astoundingly this is occurring at a time when Japan’s weighted average cost of debt is as low as it has ever been.  Clearly, any sustained back up in rates would be catastrophic for a country that already has a debt-to-GDP of 229%.


In positive news, yesterday we had more confirmation of the emerging housing market recovery in the United States.  On a year-over-year basis, the Case-Shiller national home price index was up 4.3% in October, up from a 3.0% increase in September.  On one hand, this is no surprise since Case-Shiller reflects Corelogic data on a lag.  Regardless, as our Financials Sector Head Josh Steiner has been noting, the market, media and Main Street focus on Case-Shiller and the nature of the housing market recovery is that good news will feed on itself.


Could the housing recovering reach escape velocity in 2013? It is likely too early to tell, but our models continue to suggest home price recovery will come sooner than the consensus expects.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1634-1671, $108.95-111.58, $3.51-3.61, $79.06-79.92, $1.31-1.33, 1.70-1.85%, and 1412-1450, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Getting Religion - Chart of the Day


Getting Religion - Virtual Portfolio


Today we bought Och-Ziff Capital Management (OZM) at $9.29 a share at 3:42 PM EDT in our Real-Time Alerts. The stock remains one of our top long ideas in financials. We're buying it back ahead of the financials earnings season.



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